London Tech Holdings PLC Finances - Case Study Example

Running header: Accounting Student’s name: Instructor’s name Subject code: Date of submission: Sources of finance for business There are many sources of financing through which London Tech Holdings PLC may secure funding for its various projects. In other words, the type of financing to be used will largely depend on the nature of the project being financed as well as the ability of the company to repay. The following sources of financing are available for the company; i) Raising finance through the stock market. This may be through a rights issue to the existing shareholders in a bid to raise finance from them without diluting their ownership. On the other hand, the company may decide to issue new shares for instance by listing in the stock market for the first time. The number of shares to be issued will depend on the company’s financial needs. The types of shares issued may be of two types including ordinary shares and preference shares. The main advantage/implication of equity financing is that it will not have to be repaid while the risks and liabilities of company ownership are shared with the new shareholders (Dyson, 2007). Since there is no payments, the cash flow generated will be used to further grow the business. However, the ownership of the company is diluted. The decision making authority is also shared. ii) Loan/Debt – the company may finance its activities and projects by securing long-term debts from financial institutions such as banks in which the company would have to pay interest. Other forms of debt financing that the company may use include debentures. In most circumstances, the company will be required to have security for the debt financing it acquires. The implication of debt financing is that the company will be able to undertake the intended project before it has the necessary funds. In addition, the debt in question would be paid in installments while the company ownership remains intact as well as the decision making authority. However, the debt attracts interest that must be repaid together with the principal. Inability to pay exposes the company to the threat of takeover which is not healthy for the company. iii) Retained earnings – the company may decide to finance its activities and projects through the use of its retained earnings. Retained earnings unlike equity financing and debt financing do not pose a threat to the company’s ownership or decision making authority. Neither does it expose the company to the threat of takeover while it is cheap as there are no issuing costs or interest requirements. However, its main disadvantage is that it may be a slow form of financing when the size of the project is big hence the reason why companies may opt for other forms of financing. iv) Leasing- leasing would be another method of financing for the company. Under this arrangement, the company would have to pay lease rentals for the property leased in accordance to the terms of the lease. The main advantage of leasing is that it allows the company to use and control the asset without having incurred huge capital expenditure hence releasing funds for alternative uses. However, the lessee does not get ownership of the asset but only gets the right to use and hence the asset can never be used as security to secure other forms of financing. In addition, where the company defaults, it will be deprived on the assets ownership. v) Venture capital- this would involve another party putting its money into the company for the purpose of carrying out a specific project in the hope that it will benefit if the project succeeds. Venture capital financing enables the company to expand through acquisition of finance and managerial expertise that would not be possible with debt financing or other methods. However, securing venture capital financing may be difficult owing to accounting and legal costs involved. In addition, the company must give part of its stake to the venture capitalist thus diluting ownership and decision making authority. Based on the above analysis, financing for the company should ensure a balance between the need to expand the business as well as the need to remain in control of the business. In this regard, the most appropriate form of financing for the company would be; i) Equity capital ii) Bank debt iii) Retained earnings A mixture of the above finance sources should be such that the company retains its control on the business while being able to carry out its intended projects. Importance of financial planning for the company Financial planning implies making decisions in advance regarding how much the company is to spend and on what to spend according to the funds at its disposal. It includes a number issues including i) The amount of finance the company needs to carry out its operations and projects smoothly ii) Determination of the source of funds including the pattern of securities to be issued (Clarke, 2013) iii) Determining of policies suitable for proper utilization and administration of funds Financial planning is important for the company due to the following reasons; i) It will facilitate collection of optimum funds and hence avoids wastage and overcapitalization ii) It will help the company fix the most appropriate capital structure. In essence, financial planning will allow the company tap appropriate financing sources at appropriate times from the various sources outlined above iii) Financial planning will help the company invest in right projects through comparison of various investment proposals iv) Financial planning will help the company in its operational activities trough making the right financial decisions v) Financial planning will act as a basis of financial control through comparison of actual revenue with estimated revenue and actual cost with estimated cost. As such, it will ensure proper utilization of finance. vi) Financial planning will help the company avoid business shocks and surprises since financial requirements are anticipated vii) Financial planning will help the company in coordinating its various business functions while linking present financial requirements with future requirement through anticipating sales and the company’s growth plan Financial decision making Different decision makers require different type of information to make financial decisions. As such, the information provided by the company in its financial statements is essential to its various stakeholders. Existing stakeholders such as the management, employees and shareholders will require information on the company’s sales, gross profits, expenses incurred and well as the income earned during the period as well as any dividend payments to be made. On the other hand, potential investors will be interested in the company’s current earnings per share as well as the new investments the company plans to invest in. employees will be interested in bonus payments, incentives, salaries and wages and the company’s potential survival in a bid to ensure job security. On the other hand, the government will be interested in the company’s profits and business operations so as to collect tax and other duties depending on the business nature. Impact of finance on financial statements The kind of financing that the business decides to adopt has a great impact on its financial statements. The kind of financing determines the company’s capital structure. A company should decide on its optimum mix of capital and debt. If the company should incur debt capital, then it should generate sufficient profits in a bid to meet the interest charges. If the borrowed funds are invested in projects that provide return in excess of debt cost, the company’s equity will increase. On the other hand, debt interest attracts tax savings if the company uses debt financing. When issuing shares, the company would incur considerable expenses that are not tax deductible. Furthermore, a company issuing shares through the stock exchange has to prepare its statements in accordance to IASs. Listed companies also have to disclose its various financing sources as well as other costs and interest payments made for the period. In essence, the kind of financing the company chooses to use will have a great impact on its financial statements including composition and format as explained above ((Taylor, 2012). Budgets and decision making Budgets are estimates about the company’s expected revenues as well as anticipated expenditure. In this regard, I would look at the company’s budgets for various projects and see whether the budgets are being adhered to. This would help me to prioritize spending into areas that would be most beneficial to the company while cutting down on wastage. If I anticipate a deficit, the budget would help me in looking for alternative form of financing for the company. Unit cost The company produces goods in bulk and hence various costs have to determine in a bid to arrive at unit costs. These costs include the variable costs which are the costs that vary with outputs level. Such costs include the cost of raw materials, labor among others. We also have to determine fixed costs which are the costs that do not vary with production in the short run and are fixed regardless of the level of production. Having determined the costs, they are added together and then divided by the number of units produced to arrive at the unit cost. Ie; Unit cost = (Total fixed costs+ Total variable costs)/ Total units produced Making pricing decisions using relevant information Having determined unit cost for the company, the product will be priced based on a number of factors. These include the unit cost incurred in producing the product, forces of demand and supply as well as the company policy on pricing. In this regard, the company has a policy of using markup pricing all factors being equal. In this regard, I would use the unit cost to determine the price of the product. The price will be arrived at by adding a markup of 30% on the unit cost to arrive at the product’s selling price. Appraising the project Supposing that the company want to invest in new machinery, I would consider what the company policy is on investment projects. In this regard, I would use NPV to appraise this project. This involves calculation the present value of all cash flows associated with the new plant including the initial investment outflow and the future cash flow returns (Jabez, 2009). If the project has a positive NPV, I would consider other factors such as the availability of funds before recommending for it to be purchased by the company. NPV is arrived at by using the above formula where; Ct = net cash inflow during the period Co= initial investment r = discount rate, and t = number of time periods Types of financial statements There are four types of financial statements prepared by businesses. These include; i) Statement of financial position – it represents the financial position of the business at any given date and is comprised of assets which is what the business owns, Liabilities which represent what the business owe others and equity representing the owner’s claim to the business. ii) Income statement –it reports the company’s financial performance in terms of profits and losses over a particular period. It is composed of income or what the business has earned over the period and expenses or the costs the business has incurred over the period iii) Cash flow statement –it shows the movement in cash and bank balances over the period depicting the businesses cash inflows from various sources and cash outflows to various expenses. iv) Statement of changes in equity- it details the movement of owner’s equity over the period Different organizations adopt different formats for their financial statements depending on their nature .For instance, the IASs require that companies prepare financial statements in a certain format. On the other hand, partnerships adopt a different format in a bid to reflect each partner’s contribution into the business. Sole proprietorship on the other hand prepares the statements mentioned above but they are much simplified. In other words, all businesses prepare the above four statements though their formats differ depending on size and ownership. Interpretation of financial statements We can use financial statements ratio analysis to gauge how good the company is performing. This could be done by comparing its current performance with past performance or by comparing its performance externally with other companies in the same industry. Some of the areas in which we can gauge the company’s performance include liquidity ratios that measure the organizations ability to meet its short-term liability obligations (Peter, 2006). Profitability indicator ratios measure whether the company has been operating profitably while debt ratios measure its ability to repay its debts. Other ratios measure the company’s efficiency in generating income. By comparing these ratios either with the previous periods or other companies in the same industry, one is able to tell whether or not the company is performing well. References: Dyson, J2007, Accounting for Non-Accounting Students, Financial Times/Prentice Hall. Clarke, B2013, Accounting: An introduction to principles and practice, Sydney, Cengage Learning. Taylor, J2012, Financial Planning, LexisNexis, Australia. Jabez, M2009, Fundamental principles of finance, London, Rutledge. Peter, C2006, Advanced financial accounting, New York, Taylor & Francis. Read More